TDI Podcast: Opportunities Within Chaos (#934)

27:02And, you know, meaning of the last hundred years. And part of this, of course, has to do with just something that's been around for a hundred years. So NVIDIA has obviously not been around for a hundred years, but theoretically had you invested in Altria, which would be the old Philip Morris, you would have had a, hold on, I got to do the math here on this. It's like a 265 ,528 ,901 % return. So you can, you can, uh, and it's about 16, 16 % per year, but it's funny of the top five. I mean, Vulcan materials was number two, Kansas city Southern was number three. Um, but you know, if you were to put a thousand dollars back in Altria a hundred years ago, it'd be, you know, two and a half Billy today.

27:50But the point being is that, you know, power laws where some of these positions, these 10, 100, 1 ,000 baggers end up contributing mightily to the broad stock market, which is why indexing works. That's one of the benefits of investing in everything, is you definitely own the whole haystack. The problem is, is the vast majority of time market cap indexing is okay. The problem is when you get to these periods where the market cap has no tethered evaluation, you can put a lot of weight in the stuff that's getting pretty expensive. And it doesn't mean it can't keep going up. It just means on average, that can be its Achilles heel over time.

28:33And there's a lot of places where securities are quite a bit cheaper. You know, when you look at the analogy, or maybe it's a metaphor, I don't know, I always forget which one is which, but of surfing and waves, when the waves start to crest. I mean, right now we have is this, this, this swell that builds and it builds upon itself and it builds on the inertia. And then eventually what happens, you know, the top gets too heavy and it crashes down on itself. Right. That's, I don't surf, but that's what it looks like on TV, at least. That's what I see. You know, well, it's, it's why we have settled on in my old age, you know, this concept of, you know, having, having one foot in a globally diversified portfolio with tilts to things like value and then having the other foot in a world that's tilted towards trend following.

29:25And sometimes they align and sometimes they don't. Trend following and momentum right now, if you look at our global momentum fund, it's mostly exposed to equities, but a lot of that is ex-US. It's got a smidgen in precious metals and in mining stocks. It's got a smidgen in Bitcoin and related, but the majority, you know, is long, right? Like it's, it's a, there's no bonds. I don't think there's any REITs in that world, but it's, it's a long exposure that I don't think would surprise anyone. But, but so that, but a lot of what has been going up is also currently cheap. So to me, that's sort of a perfect setup across the board when those two align, but they often don't.

30:12What is, what is the risk these days? And what I ask you about when I say risk, how do you define risk in today's market environment, right? When things have changed dramatically in how we perceive risk. I've recently started talking about, you know, we had the continuation since, I don't know, forever. But it seems like forever. But since the big bailout in 2008, 9, 10, and then the continuations was over the years, the buy the dip mentality, right? that anytime you see a big, significant correction in the market, we have this V return, there's going to be a savior. But these days, that doesn't seem appropriate to say that.

30:52I've talked about the movie Legally Blonde when Elle Woods did the bend and snap. Remember that? That's kind of what we have in the markets now. You only have to have like a 2 % one-day correction and everybody piles back in. is risk is a stupid question, but is risk is risk left the room at a, with, with a VIX at 17 with a market that doesn't seem to want to come down for too long for maybe days versus months. Is it, is something changed? You know, I think the big risk is, is any investor, and this isn't just individual, this is institutions too. The number one risk is, and always will be in my mind, getting taken out of the game.

31:35So you're in a portfolio, you're in positions that either are far more volatile or riskier, or there's a mismatch between liquidity. We saw that with a lot of institutions during the global financial crisis, some of the smartest money out there, the endowments on and on, whether it's through leverage, whether it's through private investments, on and on is getting in a situation that you didn't foresee or expect as being possible and a lot of that just tends to be drawdowns, right? So if a particular investment goes down 50, 75%, you know, people, it creates a lot of problems for them. So getting taken out of the game to me is always the number one risk.

32:17So even if stocks are expensive, even if they go through a 50 % bear market, if you're a long-term buy and hold investor, so what? Who cares? Like it's an opportunity to buy stocks 50 % cheaper than they were, you know? But I think a lot of investors have the mentality of a just wing it. We ran a poll that was very depressing to me yesterday on Twitter and we've run it over the years. So I just, I don't know why I keep running it because it just keeps depressing me. But, you know, we were chatting with Ken French, the professor on the podcast not too long ago. And I said, how long does it take to know that an investor is good, that they have skill?

32:53And without skipping a beat, he goes 64 years. And so I was like, okay, that's a little longer than I was expecting, but I asked my followers on Twitter and I said, what stretch of underperformance by a portfolio manager would you be willing to tolerate before selling the allocation? So listeners think about it for a second. And it was zero to five years, six to 10 years or over 10 years. And 70 % said zero to five. And, you know, another 20 % said six to 10 and 8 % said over 10 years. But the point I was trying to make is, you know, you can replace the portfolio manager with asset class. You can replace it with all sorts of different exposures, value, small caps.

33:35And yeah, and all of these things go through periods of under or outperformance. Like I don't think many people know, but gold and REITs have outperformed the US stock market this century. You know, that's a 25 year period. And yet, you know, I think everyone focuses on one asset. So, you know, I think trying to come up with a plan and thinking long term is important so you don't get taken out of the game. So that having been said, to me, the big risks are I don't see most of the fixed income marketplace having enough yield relative to T-bills. So through, I think, you know, some of the riskier corporates or emerging markets on and on 30 year, you've had this sort of weird inverted yield curve period that's lasted for quite a long time.

34:21And then some of the really expensive stuff to me seems quite vulnerable. But other than that, I sleep easy, you know. Well, what's interesting is that, you know, you mentioned the yield curve and you mentioned the spreads. I mean, they're tight that people are reaching. Trying to get any kind of yield on a municipal is impossible. You look at the high yield market, it's like, well, that's fine. Let's just get right in there. There's seemingly no risk. And I think some of that has to be said that during that period when we had that inverted yield curve that was really heavy. And do you remember when the banks were all in a panic for a little while there?

34:57Where we had the situation where Schwab and all these guys were freaking out because they had all these treasuries. And all of a sudden, was that, I guess in 2022, 2023, when all of a sudden their mark to market on their bonds was just ridiculous. And then the Fed comes up and says, hey, don't worry. We'll buy back from you at full price. We'll hold them. What do we want? We don't care. Well, so we wrote a paper on this a couple of years ago called T-bills and chill most of the time. And the thesis was, hey, let's examine historically, has it been a good idea to buy these risky bonds when you're not getting much pickup and yield spread versus T-bills?

35:34And historically, it's been a bad idea. But what you find is price insensitive buyers. So you have a lot of these institutions that for a long time they had zero yield on their bond portfolio. And all of a sudden they wake up and they have 5%, 6%, 7%. So they're buying them regardless of the fact that you could buy a safer investment at four and a quarter. And so it's created this really weird setup. However, historically, it's been a bad idea. And so looking at all of the entire risky bond curve, it seems like you're not getting enough yield. But if we know anything about markets, something hits the fan.

36:11And I thought it was going to happen in March, April, where traditionally those spreads are very highly correlated with the VIX. And so usually when the VIX blows out, the corporate spreads blow out, the junk spread blows out. And it wiggled a little bit, but not much. Not much. So that would make me nervous if I had a ton in those type of assets. But, you know, it's more of an underperformance relative sort of situation, too. You know, last time you were on was back in February. And at that time was getting personally close to that whole March, April time period, right? Because we started feeling some of the things that could be going on.

36:47There was some murmurs about the tariffs and all that. You know, I leave in my studio here just for the hell of it. Do you remember when they went up and they, Navarro, Trump, and a few of the other guys were announcing the reciprocal tariffs? and they had those boards up with the 36 % and 80 % and 90%. Madagascar, that heavy trading partner that we have, Madagascar at 93%, and Serbia at 74%. I don't know about you. I get all my clothing from Serbia, right? But there was a much different environment back then, right? And not much has really changed fundamentally aside from the threats from all these excessive tariffs.

37:29But yet markets seemingly are finding every single day another reason to feel good about something. What is that? What is going on there? You know, you can go back to a lot of the ideas about markets discounting the future. I mean, we often tell investors, we're like, look, this is as good as it gets. Unemployment's low. Inflation's low. Stock market's at an all-time high. Like, this is rosy. You should count your blessings, appreciate how much money you've made over the past 10 to 15 years, but maybe just not expect. I love to watch the sentiment surveys to see where we are. And back in the late 90s, which I believe you recall, they would ask investors, what do you expect stocks to do?

38:17and this is Bernstein, December 99. And all investors said 19 % per year. And if you were under 40, you said 22%. And then, you know, this happened again in like 2021. There's an annual, I think it's by Natixis does a study. And we tweet these all the time. And, you know, it was like 17%. But that was actually after inflation. So let's call it 20 % again. And so people, you know, they just extrapolate whatever's happened in the recent past. Again, it doesn't mean it has to be zero or negative. But if we know anything about markets is that normal market returns are extreme. It's not like it does 8 % every year.

38:59It does plus 25, minus 10, flat, plus 4, plus 30, on and on. You know, and so the thing we've been rolling out this year is this new idea about 351 ETF exchanges. And so for people that feel stuck, like the problem most people have is they're like, look, this is awesome. But, Meb, I was 60-40 in 2009. Now I'm 90-10 because my stocks have gone up so much. But I can't sell them because the tax man will kill me. And, you know, we've kind of, with our friends at Alpha Architect and others, have developed an idea where you can seed ETF launches and contribute these highly appreciated positions and get an ETF in return.

39:37And that's a potential diversification idea for people that feel like there's nothing they can do about it. They feel helpless, which is a pretty cool way to diversify those positions. But that to me is the, you know, when you see people thinking there's going to be 20 % returns, I get a little nervous. Because with 20 % returns, you quickly become the richest person in the world. Oh, yeah. You're doubling of, it's almost like doubling a penny every day. That kind of concept. I want to talk about the 351 funds, but I want to first – I want to ask you about private equity and get into this for a second because there was this push for some time to buy the parties that would have the obvious incentive to do so to get things like cryptocurrencies in 401Ks or cryptocurrencies approved for ETFs or cryptocurrencies for fill in the blank, okay?

40:30So that the masses can get in. Why it's such a good idea and all that. Like, listen, it's because they want to have more exposure. And I'm not blaming them. They want to get more exposure. Let's just say what it is, though. That's what it is. You know? Okay. They want to make it easier and all that. Fine. Private equity. I was at an event with you in Miami a few months ago. Remember that? Mm-hmm. Okay. And let me tell you something. I don't know what it was, but, like, everybody's like, I didn't ask any questions. People are in my face, literally in my face, telling me how I should have private equity exposure in my portfolios.

41:02I'm like, did I ask you? I didn't ask you. You know, and this is going on and on, like the whole evening. It was weird. It was very weird. I don't know if you had that same, I was only there one night. You were there for a few days, but at the event. But I was like. You know, I mean, if you go to the institutional conferences or like the, even the slightly more retail advisor focused ones, you know, every year there's a different theme. And, you know, the people that are on the kind of periphery peddling the, whatever the hot wears on it. So if you went back to 2007, it was the bricks. Hey, you had to invest in Brazil, Russia, India, China.

41:34Then after the GFC, it was anything tail risk or trend or diversifying. And then it was, you know, on and on different shiny objects, China, Chinese stocks. And then it was SPACs. And then it was, you know, this cycle has certainly been a huge uptick in private equity, private credit. You know, we've long held the belief. There's a couple of comments I'll make on it. One is, I think the biggest benefit of private equity is breadth, meaning, yeah, you got thousands of public securities, but on the private side, there's 10 or 100 times as many private businesses. So just the amount of choice is interesting to me.

42:14However, there's been a massive, massive amount of money that's flowed into that world over the past 30, 40 years. And so what used to have been a pretty inefficient, low competition space is now hugely competitive and a ton of money has, you know, like people, we wrote a book on this. People follow the Yale model and these others who were pioneers in kind of some of these inefficient ideas. But now every, like you mentioned, if you're talking about it at a happy hour at a conference, that's probably an asset class that at this point has been, you know, widely, widely, you know. Wrung out. Yeah.

42:56And so there's obviously the problem of the fees. The illiquidity can be a plus or minus depending on your point of view. The transparency is a huge problem. Yeah. I mean, I've seen some of these. We have clients that usually what happens is we adopt these, right? We have to bring client in and they got – I had some clients recently that were with an advisor in, let's say, on the East Coast. And this guy flooded him with a few of these clients with non-liquid, non-liquid hedge funds slash private equity slash interval funds, which, again, everything has its purpose. I get it, right? There's reasons for all this, especially for high net worth.

43:33Clients that can do – can withstand having illiquidity on some of this. But I'm thinking, why are we having this interval fund that when you look at the performance, it's like that one is particularly no better than anything else out there that's an open-end mutual fund for that matter. Why do I need to be locked up in it and extra fees? I just didn't understand. I don't understand that one. But the second thing was I asked the clients when they came in. Again, there was several of them over time. What is it that you have? I don't know. Why do you have these? Well, the advisor would send me. This advisor was managing their money.

44:06They would send me these ideas, these things, and says, do you want to invest in it? I'm like, wait a minute. They're asking you if you want to invest in it? Like whiskey barrels, you know, that kind of thing. Yeah. Or some kind of, you know, real estate that does this or that. I mean, and then you get locked up with capital calls and then with illiquidity. And the transparency is the biggest thing that really bugs the crap out of me. Well, there's no question in my mind, all the academic literature shows that everyone in private equity and to an extent venture capital too, makes one argument, which is, hey, the whole point is you're trying to outperform and you got to be top quartile.

44:46And of course, my fund is top quartile that I'm selling to you. And the problem is if you look at the academic literature, private equity and venture capital can be replicated in public markets with tilts towards certain characteristics. and we've done a bunch of podcasts on this topic and over the years with Dan Rasmussen and others. And once you understand that, then, you know, it's kind of hard to accept all the high fees and illiquidity private equity. And you've seen some private equity replication ETFs launch. And one of my favorites that I've been talking quite a bit about, you know, to achieve the private equity venture capital replication, they'd leverage the portfolio.

45:33And so a lot of the private equity, you know, and the ones that are, I think are a little sus as my, my son would say, but a little questionable on their ethics and morals. They'll say, yeah, this private equity fund, this private credit, it's got a volatility of four. And I'm like, first of all, we both know that it doesn't. And not only is it not stock, like it's 17%, it's probably 30. And just because as you look once a year, doesn't mean that it's not volatile. And so a great proof is that to replicate the returns of private equity in VC, this ETF is leveraging the portfolio over two times public equities.

46:09So that means your vol is like 40. And so, you know, I think a lot of people don't realize that. And then, you know, the challenge that you mentioned that's so important is the mismatch on liquidity. You have a big drawdown and all of a sudden, you know, you got to sell something. And what are you selling? Well, you got to sell your public stuff. And then now your entire portfolio is private equity. So it's, look, for the people that know what they're doing, I think you're, you know, go for it. I just don't think it's necessary. I don't think you need it. But the other thing is that they're looking at when they present the public version of the private, a lot of times they're giving you the track record of the private, which is usually unleveraged, smaller, held for a long period of time, not as liquid, which gives them some advantages potentially, right?

46:58It hides some of the blemishes. Yeah. And you have all of a sudden that's what they're using as their best match of historical performance, and that's what they're selling. Now, you've got to be careful because I also need to disclose that a huge portion of my public, excuse me, my private assets are in startup company angel investments. And so I've been doing this for over a decade now. And there's certain benefits to startup investing. If you invest in a company that's under a 50 million, and this was Pat's QSBS rules was passed under Obama and now updated under Trump to 75 million, but you get a massive tax benefit.

47:44And I actually personally think this is one of the most interesting and impactful pieces of legislation either side of the aisle has implemented. So it's been on both sides over probably the past 10, 20 years, because it hugely incentivizes startup creation in the United States, which is a unique phenomenon versus the rest of the world. It's just leagues ahead of anywhere else. And so the benefit of the QBS, if you invest, it's like a 10X on your investment or 10 million. I can't remember the exact numbers that have been updated is tax exempt. So for investors in this small world, and so we wrote a long post on this if you're looking for more information called Journey to 100X.

48:23If you want to learn about that world, you don't even have to participate, but just follow along. I think it's a hugely interesting idea, really fun, optimistic way to think about markets. But these are sort of things you put in the lockbox and put away. And I think I'm getting Being ready to cross probably in the next few months, my 400th angel investment. And that's, that's, that's good for disclosure. But you're also looking at these and this is your strategy and that's what you want to do. Different than being peddled this stuff. Well, they'll, they'll come at you too. Yeah. But, but being peddled as a non-investment dude, right?

48:57Yeah. With thinking that this, and then it's not fair. It's, it's, it's, it's a total. Yeah. So do you think though that private equity should be, we'll close on this point. close this topic, allowed into 401k plans? Is that something? Well, let me back up for a second. We've talked about this. Are we any further along with not getting rid of just the mutual funds in 401k plans? When are we ever going to get the ETFs in there? And it can be end-of-day ETFs. Is there such a thing we can create called end-of-day ETFs? Let's work on it. We'll figure it out. You and I put our heads together on a fishing boat or over a beer or something and solve that.

49:39But yeah, I hear you. So talk to me about the 351 exchange funds again, because we talked about this last time. It was fascinating. Where are you in that that you obviously evolved and you have a lot more going on now with that? Sure. So, you know, I think when we talk to investors, thinking about fees and taxes, taxes to me are always like the number one source of alpha that everyone sort of overlooks. And ETFs have been a game changer for a lot of people for this. On average, if you're buying an ETF, you're not going to be paying any capital gains on that fund until you sell it. So it'll rebalance.

50:13And it's a really awesome benefit for the individual investor. And this is why you've seen a huge amount of flows out of the traditional high-fee, tax-inefficient mutual fund world towards ETFs. Great. I feel like everyone kind of knows that here in 2025. However, you know, as alluded to earlier, there's some challenges people have if they're in investments. It could be stocks. It could be ETFs that have appreciated in a taxable account. And then they want to rebalance or they want to sell some or they want to sell all or they're a CEO and they had massive liquidity and 95 percent of their wealth is now in one stock.

50:52Or you've been doing direct indexing for a long time and your portfolio is up 5x and you're stuck in all these companies that have appreciated. There's not a whole lot of options historically. There's some fund developments from AQR and others on kind of direct indexing 2.0 that's long, short and leveraged. But those can be complicated. And so anyway, you know, we talked about this where there's 351 has been in the tax code for like 100 years. But the magical partnership really came with the ETF rule passing, say, five years ago. Essentially, there's a lot of info online. Listeners, you can find it if you Google my company, Cambrian 351.

51:28We got PDFs and videos and everything. But the simplicity is you can seed or contribute a portfolio to the launch of a new ETF. So we did one last December. We did one in April. We got another one coming up in September and December. And you get the ETF in return. And that is a tax deferred event. So it's not a tax wash. That would be legal. But you're deferring taxes. So, yeah. So you defer taxes. you do it in the seeding of an ETF, which is an efficient way to do it. And then you mix it up with other parties? Or is it - Yeah, so let me walk you through how the next one will work. So we're launching a fund in September, mid-September.

52:13It's called GU, G-E-W. And this oddly doesn't exist. So we're interested in launching this one. It's the top 500 stocks globally equal weighted. so gives you exposure to all the countries in the world top 500 it kind of breaks that market cap link so it's for people that want a beta sort of quant exposure all in it's only 25 basis points so you're contributing there's no cost there's no cost to setting this up and let's say you got a mag 7 portfolio or let's say you got 10 or 20 stocks you want to contribute it may be you and 10 other, or maybe 100 other, maybe 1 ,000 other investors. And a couple notes.

52:55One of the regulators, they said, look, we don't want this to be a situation where people are doing this for tax reasons alone. So you have to contribute a diversified portfolio. And so the number one rule is that the biggest position can't be over 25%. So you couldn't just give me$10 million of your NVIDIA. It could be$2.5 million, but it's got to be$7.5 million other stuff. It could be stocks. Now, the cool part is ETFs are look through. So you could actually give us 100 % SPY because it looks through to the underlying holdings. And so, you know, for this fund, it could be U.S. stocks, foreign stocks, or ETFs.

53:36And the one we're doing at the end of the year is a U.S. top 500 equal weight. So that would be U.S. stocks and ETFs only. and then you get the portfolio back. And the cool part is, let's say you submitted 20 positions. Well, you get back an ETF, but it's got 20 different tax slots related to the initial positions you contributed. So you could manage the new ETF very precisely if you wanted to sell some or all going down the road based on the initial contributors of your, like you mentioned, your client's$3 NVIDIA position. Right. So it's just a flexible way to diversify for the people that feel offsides and don't want to make wholesale changes today based on tax reasons alone.

54:20Because if we know anything about markets talking to clients forever, almost always when people make decisions based purely on trying to avoid tax, you say, I can't sell this. Taxman is going to kill me. and say, well, the market's going to solve it for you someday. It doesn't matter if it's IBM or GE or, you know, whatever the position may be eventually, you know. Well, that's what we talked about before we got on. The tax man doth take it. We talked about the tuna and Cabo fishing. And, you know, you catch three tuna and the tax man in this case is the sharks. It takes two thirds. You have no choice on it.

54:54You could be a little bit smarter, real a little bit faster. But in the end, there's a tax to pay. It's what it is. Yeah. Yeah. Yeah, I hear you, buddy. But, you know, the tax alpha, I think just making smart decisions on taxes in general is much easier than trying to decide what the Fed's going to do, where gold's going, how to, you know, will this expensive market keep going up, on and on. You know, the simple, and that's the beauty of financial advisors. So on this 351, you have to go through a financial advisor. or the custodians won't let individuals participate because they're like, we're not herding cats.

55:32I think this is, we've said this is a bigger idea than crypto ETFs. And I think, and that's a pretty big idea. That's over a hundred billion. I think this will hit mainstream in 2026. You'll start to see some of the big boys. And I hope you get the majority of it, sir. That's what I hope. Me too. That's what I hope. MedFaber, always great to have you on board. I'm going to have all the information on how to get in touch with you and your podcast, your books, your papers, your firms, your 351s over on the show notes. Episode number 934 on thedisciplineinvestor.com. Thanks, buddy. I'll see you soon.

56:06As always. Great. Thanks. That's going to wrap it up for this midsummer. It is the midsummer. This midsummer podcast, episode number 934 of thedisciplineinvestor.com. Like I said, go over to thedisciplineinvestor.com and check out all there is available for you there. You can check out how we do what we do, how we manage money for clients, if it's right for you. Maybe there's something you've been thinking about and maybe one of the strategies that we work on with clients is really appropriate for you. Check it out. Go there. Make sure to be here next week. We have some great guests coming on.

56:40We have, let's see, Daniel Park, Nolan Lankford, Jack Schwager. That's just in August, so stay tuned. Lots of good things happening. I'll see you soon.

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